Tuesday, June 30, 2015

Tim Worstall — But this is impossible under modern monetary theory!

Or perhaps we should revise that to a “this is impossible under a deeply deluded understanding of modern monetary theory”. For there’s a certain segment of the populace who insist that banks just make up money out of thin air.
"There’s a certain segment of the populace who insist that banks just make up money out of thin air." That would include the Bank of England.

See my comment there.

Adam Smith Insitute
But this is impossible under modern monetary theory!
Tim Worstall

7 comments:

Dan Kervick said...

I don't think this part is right Tom:

"The central bank is committed to clearing all interbank payments by making liquidity available as the manger of the payments system and lender of last resort."

The central bank is not committed to automatically loaning a bank whatever liquidity they might need. If the bank is insolvent, they may shut it down rather than lend. The FDIC is responsible then for the deposits under $250 K.

Dan Kervick said...

I don't think this part is right Tom:

"The central bank is committed to clearing all interbank payments by making liquidity available as the manger of the payments system and lender of last resort."

The central bank is not committed to automatically loaning a bank whatever liquidity they might need. If the bank is insolvent, they may shut it down rather than lend. The FDIC is responsible then for the deposits under $250 K.

Banks lend against their assets, and if their liabilities exceed their assets they are bust. But only a fraction of those assets need be in the form of reserves at any given time, and if they are short reserves but have an adequate capital position they can borrow reserves against their capital.

John said...

Why does the myth of fractional reserve banking continue? Given that Canada (and possibly other countries) doesn't have a reserve requirement, and yet Canadian commercial banks create credit, you'd think that this simple example of credit creation without a reserve would defeat the fractional reserve crowd. But no, evidence, it seems, is an irrelevance.

I see from wikipedia that Australia, New Zealand, Sweden and the UK (shamefully, I didn't know that) also don't have reserve requirements. For some reason, I was under the impression that Canada was the sole reserve requirement free country. So that's five advanced industrial capitalist countries without a reserve requirement, yet the fractional reserve mumbo jumbo persists. Presumably the answer is that once you discard the reserve requirement, endogenous money becomes the automatic and only answer. And endogenous money disproves a lot of economics and leads us to some very interesting ideas about economics and national economies.

Tom Hickey said...

That is true, Dan. I assumed two key points without stating them. The first is that banks are members of the payments system. Not all banks are. Smaller institutions have institutional relationships with member banks. Secondly, that the relevant banks are solvent and in good standing.

The Greek banks in question are members of the payments system and no one has found them to be insolvent at this point, although depriving an institution of liquidity could result in insolvency. A job of the central banks is to make sure that banks don't become insolvent for lack of liquidity. The Fed provided tens of trillions in special purpose liquidity to prevent that from happening in the US for example, and it also did so for large non-US institutions that were considered financially crucial owing to systemic risk.

Roger Erickson said...

Apparently, 99% of electorates don't read Wikipedia (or much else), Dan.

Nor do they actually THINK about what they read. :(

Neil Wilson said...

"Smaller institutions have institutional relationships with member banks. "

That creates a three layer structure very similar to the Euro. In the UK we have building societies and credit unions that have normal bank accounts with clearing banks.

Back in the old days there were only four clearing banks in the UK and everybody else had to operated through them - which meant the clearing banks managed the overdraft situation and shut down other financial institutions.

Deregulation meant that the smaller institutions could get a clearing account directly at the Bank of England and cut out the middleman. That of course was a centralisation move and made the system more brittle because the BoE didn't employ all the policemen that the old clearing banks had.

So that's another argument against the Sovereign Money idea. We've already had a forced centralisation of banking regulation and the results were pretty clear in the UK.

In a rational economy the central bank is forced to provide liquidity to ensure the payment system clears. When they stick to their ideology, as the Bank of England did with its open market transaction approach in the early days of the crisis, then things get very bad very quickly. All of a sudden the BoE is forced to go to Interest on Reserves and create a discount window which continued to get wider and wider as the crisis unfolded.

If you have an irrational economy run by idiots then the central bank can starve the system of liquidity, in which case the payment system will collapse.

Hence Greece.

Once you move to irrational behaviour then all bets are off. MMT can only help running a rational system in a more efficient manner.

Neil Wilson said...

Worstall is turning into a bit of a James Delingpole. Telling his readers what they want to hear.